In December, prepayments on Fannie Mae's 5.5 percent securities, containing loans with 6 percent rates, averaged a pace that would erase 27 percent of the debt in a year. That compares with a peak of 45 percent in 2003, when loan rates reached as low as 5.21 percent, and fewer mortgages were being retired by foreclosures.

 

Obama's three-year-old Home Affordable Refinance Program for Fannie Mae and Freddie Mac loans with little or no home equity is being expanded to help homeowners by cutting lender risks, lowering fees and allowing borrowers to refinance no matter how much their home's value has dropped. The changes, which started in December, followed the program reaching less than a quarter of its 4 million to 5 million target.

Bernanke's Fed study said "more might be done," including eliminating entirely the reduced fees for risky loans, "more comprehensively" cutting lenders' put-back risks; and further streamlining refinancing for other Fannie Mae and Freddie Mac borrowers. The U.S. also should consider having Fannie Mae and Freddie Mac refinance loans not already backed by the government, which would add credit risk for the companies, according to the report.

Corinne Russell, a spokeswoman at the Federal Housing Finance Agency, which oversees the mortgage firms, declined to comment on the paper.

The limitations of the government's Home Affordable Refinance Program meant that Karthik Narayanan, who bought a house in Gilbert, Arizona in 2007 for $300,000 that he estimates has lost $100,000 in value, gained only minimal benefits.

The software engineer refinanced under HARP in October 2009 into a 5.3 percent rate, using cash to pay off a $30,000 home equity loan that he had used to fund half of his down payment, because he was told he couldn't otherwise qualify for the program. Then he heard that HARP was being expanded and looked to cut his costs further, only to discover that loans made after May 2009 still don't qualify.

"Help the people who are responsible, who are trying to stay in their home, that's what I would say to" Bernanke and policy makers reading the Fed chief's report, Narayanan said in a telephone interview. He might pay down his mortgage faster or buy a second home to rent out with the savings, he added.

Though the bigger ideas in Bernanke's report may sound good, "repercussions" would include further entangling banks and the government in housing, said Jim Vogel, a debt analyst at FTN Financial in Memphis, Tennessee. That could limit financial companies' access to capital and make it impossible for the U.S. to unwind its involvement in mortgages for decades, he said. The study said it avoided discussions of "longer-term restructuring of the housing finance market."

"They say they're not going to think about the future of the system, but that leaves such a large, empty spot in the white paper," Vogel said.

Some actions taken thus far by Congress and Obama's administration have recently added to challenges for housing.

To pay for a payroll-tax cut extension last month, Congress directed Fannie Mae and Freddie Mac to boost their annual fees for guaranteeing mortgages bonds by at least 0.10 percentage point. The FHFA said it must further raise the charges, which lenders tack on to borrowers' rates, to better reflect the companies' risks.

The Fed is getting "a very low pay-off for the amount of risk they're generating," said Sanders of George Mason.

The central bank is funding its portfolio mainly with cash borrowed from banks at 0.25 percent, a financing cost that will rise when it raises its benchmark for short-term rates. The central bank may lose money on the investments if it sells the securities after increases in long-term rates, or pays more on its borrowings than the yields on its holdings. The central bank would take those steps to stem inflation.

Yields on Fannie Mae 30-year mortgage bonds trading closest to face value -- the focus of the Fed's buying because they most affect loan rates -- have averaged 3.1 percent since the central bank started reinvesting in October, data compiled by Bloomberg show. That compares with 4.3 percent during its initial buying.

They'll probably "make out like bandits" for several years as interest rates that guide the Fed's funding costs remain close to zero, Sanders said.

While the Fed has pledged to hold short-term rates near zero through mid-2013, George Goncalves, head of interest-rate strategy at Nomura Holdings Inc. in New York, says he can envision its target rate reaching 3 percent by 2017.

"The good news" is that the Fed pays zero percent on about 40 percent of its liabilities because it can print money, said Doug Dachille, chief executive officer of First Principles Capital Management LLC in New York, which oversees $8 billion.

The projected average lives of Fannie Mae-guaranteed securities with 3.5 percent coupons, which accounted for the largest portion of the Fed's purchases last week, would extend from 5.2 years to 10.8 years if rates rose 3 percentage points, according to data compiled by Bloomberg. That means the central bank could be stuck with them for longer and their value would drop more with further increases in interest rates.

"Rates go up, and you're going to see a pretty significant level of extension in terms of the duration and meaningful book losses residing on the Fed's balance sheet," said Jason Callan, head of structured products at Columbia Management Investment Advisers LLC, a Minneapolis-based firm overseeing $170 billion in fixed-income. "That's kind of the name of the game in mortgages."

A report by the New York Fed in March discussed how the central bank's net income can remain "sizable" even if it sells some bonds at losses, while Sack said in July that the central bank's bond portfolio will earn about $500 billion from 2009 to 2018.

"There should be no confusion, no mistake, that we've put duration risk onto the Fed's balance sheet," Sack said in 2010. "These decisions are being made to produce economic outcomes" rather than "to produce a certain return on the portfolio."

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